Not yet ripe

It is certainly an exciting dream to envision a situation wherein the world feels that holding rupees is as prudent as holding dollars. But this is still a pipe dream. Fiscal policies cannot be framed on illusions

The Government of India is pitching for full convertibility of rupee. The NDA government feels that this move to open up even capital account would broaden and deepen India’s capital markets to enable it to become a leading global economy. Even the Reserve Bank Governor has indicated that the central bank is looking at allowing full capital account convertibility in a few years. Full capital convertibility means a foreign investor can repatriate his money into his local currency at will which is not allowed in India as of now.

The protagonists of this policy move believe that full convertibility can help in a big way in developing global financial services hubs in India. On the contrary critics feel that India‘s policy of allowing only a partial convertibility of rupee helped the country to tackle global headwinds, including that of currency melt down in many South Asian economies in 1990s and even the recent global financial crisis of 2008.

There are many preconditions that need to be met before embarking upon full convertibility. Otherwise this move can lead to capital flight landing our economy into precarious balance of payments situation. Such preconditions include substantially higher tax-GDP ratio, containing fiscal deficit etc. India is far behind in this regard. The combined fiscal deficit of Centre and States put together is still very high.

The developmental imperatives and public policy premise make it difficult to reign in fiscal deficit. The other important precondition for opening up capital account is to have a much larger share in global trade so that other countries settle payments in the Indian currency and hold our rupee stocks with confidence. Even the International Monetary Fund (IMF) stopped recommending full convertibility after the Asian economic crisis.

It is true that India has comfortable foreign exchange reserves today. The Current Account Deficit (CAD), which has reached alarming proportions, has come down to a comfortable level. But all this do not mean India has no external vulnerability and can afford the luxury of capital account liberalisation. The short-term debt forms the major part of our external debt indicating foreign exchange payment commitments.

The volatility of stock markets still continues. Long-term policy paradigm shift like full convertibility cannot be affected relying on this foot loose capital flows. The ongoing luxury of very low global oil prices cannot always be relied upon. Even the latest Economic Survey point out that India’s external trade performance is not so encouraging given the sluggish global demand. It is certainly an exciting dream to envision a situation wherein the world feels that holding rupees is as prudent as holding dollars.

But this is still a pipe dream. Fiscal policies cannot be framed on illusions.Despite having more than three trillion dollars in forex reserves and a huge current account surplus, China, the giant economy has not yet opted for full convertibility. Any hasty policy shift would lead to dollar drain driving Indian economy to a brink of fiscal disaster.